Wage subsidy could mean more jobs

What started out as a government intention to give the youth a boost into the labour market has turned into a political battleground where chest bumping overshadows the need to address the problem. But what are the economic dynamics behind the proposal to offer a wage subsidy to employers who agree to hire youth?

The original problem is that the supply of labour exceeds its demand. Employers therefore prefer to select older and more experienced workers over their younger and less skilled counterparts. Studies show that formal education is not the dividing factor, as many older workers do not have this either, but rather the time spent in the field.

The youth wage subsidy policy attempts to adjust employment levels from the demand side of the market. It is designed to change the incentives of employers. A rational employer will always choose to employ in a manner that maximises the productivity per cost ratio. There are two ways to increase willingness to employ at a given level of gross domestic product: increase the productivity of workers, or decrease their wages.

Increasing productivity is a long and expensive road. It requires investments in the education system, reviews of the legal framework, and improvements to technology and infrastructure. But wage subsidies may play a part in speeding this up.

Given that experience and productivity is the dividing factor between the youth and older workers, the subsidy is an attempt to fast-track younger workers into the job market. It is essentially an apprenticeship programme and can be thought of as the government outsourcing education; instead of paying for complex training systems it is subsidising the private sector to do it.

Unions propose that the policy will cause older workers to be replaced. This is partly founded, but the same outcome would result from any programme that empowers and increases the capacity of the youth.

The claims are only partly justified because changing their incentives does not mean employers will opt for replacement.

First, for certain firms the subsidy may not be enough to compensate for the poor productivity of inexperienced workers. Second, in order to replace experienced labour, firms will need to factor in the costs of recruitment, retrenchment, administration, and training. This makes employing the new, lower-priced youth labour far more expensive than just the stated wage.

Third, the real benefits will be felt where the subsidy boosts the incentive for firms to increase the size of their workforce. Where machinery and labour are interchangeable, in a packing or sorting process for example, the wage subsidies may incentivise employers to replace their mechanised operations with labour. This will not threaten the jobs of existing workers but will give the newly employed youth an invaluable insight into industry.

The policy will also be beneficial where a cheaper labour pool helps firms to expand. This temporary dynamic will last only for the period of the subsidy, but the benefits to the economy of increased employment, training and production during this time will have lasting effects.

The likelihood of labour replacement practices is not as large as is being proposed and the most valid criticism of the policy is that the market may simply not respond. This is not a problem because the smartest attribute of the policy is that the government only pays if and when benefits are delivered.

Pierre Heistein is the convener for UCT’s Applied Economics for Smart Decision Making course.

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